M ACROPRUDENTIAL P OLICY : P ROMISE AND C HALLENGES Enrique G. Mendoza Discussion by Luigi Bocola Northwestern University and NBER XX Annual Conference of the Central Bank of Chile November 11 2016
T HE P APER • Paper surveys advances in the literature on quantitative models with collateral constraints • Promise of these models • Financial amplification allows model to reproduce key features of financial crises (qualitatively and quantitatively) • Scope for financial policies, both ex-ante (“macroprudential") and ex-post • Challenges (for policymakers) • Optimal financial policies difficult to implement (complex, lack credibility) • Need coordination with other policies
O VERVIEW OF D ISCUSSION • Review the main arguments of the paper • Two main points of discussion along the way 1 Role of quantitative analysis in this class of models 2 Scope for other prudential policies coming out from models with collateral constraints
A P ROTOTYPICAL M ODEL
A P ROTOTYPICAL M ODEL
A P ROTOTYPICAL M ODEL
A P ROTOTYPICAL M ODEL
A MPLIFICATION Models with collateral constraints display financial amplification • Suppose that the collateral constraint tightens (E.g. ★ ✔ t ) • Economy can borrow less, but needs to repay b t ✮ Spending in consumption, intermediate inputs, and capital drops • Asset prices drop (because of drop in capital demand) • Value of collateral declines even further • . . . Key : Amplification stronger the more levered the economy is (the higher b t )
R OLE FOR F INANCIAL P OLICIES Ex-ante interventions ✮ Imposing restrictions on leverage might be welfare improving because of pecuniary externalities (Lorenzoni, 2008) • Suppose collateral constraint does not bind today (“normal times") • Households’ optimality condition for increasing debt u ✵ ✭ C t ✮ ❂ ☞ R t E t ❬ U ✵ ✭ C t ✰ 1 ✮❪ • Planner’s optimality condition for increasing debt ✷ ✸ ✹ U ✵ ✭ C t ✰ 1 ✮ � ✔ t ✖ t ✰ 1 ❅ q t ✰ 1 ❅ C t ✰ 1 ✻ ✼ u ✵ ✭ C t ✮ ❂ ☞ R t E t ✺ ✿ ✻ ✼ ❅ C t ✰ 1 ❅ � b t ✰ 1 ⑤ ④③ ⑥ ✕ 0 Planner internalizes that higher leverage leads to more sensitive asset prices if constraint binds tomorrow. Households’ don’t.
R OLE FOR F INANCIAL P OLICIES Ex-ante interventions ✮ Imposing restrictions on leverage might be welfare improving because of pecuniary externalities (Lorenzoni, 2008) • Suppose collateral constraint does not bind today (“normal times") • Households’ optimality condition for increasing debt u ✵ ✭ C t ✮ ❂ ☞ R t E t ❬ U ✵ ✭ C t ✰ 1 ✮❪ • Planner’s optimality condition for increasing debt ✷ ✸ ✹ U ✵ ✭ C t ✰ 1 ✮ � ✔ t ✖ t ✰ 1 ❅ q t ✰ 1 ❅ C t ✰ 1 ✻ ✼ u ✵ ✭ C t ✮ ❂ ☞ R t E t ✺ ✿ ✻ ✼ ❅ C t ✰ 1 ❅ � b t ✰ 1 ⑤ ④③ ⑥ ✕ 0 Planner internalizes that higher leverage leads to more sensitive asset prices if constraint binds tomorrow. Households’ don’t.
R OLE FOR F INANCIAL P OLICIES Ex-ante interventions ✮ Imposing restrictions on leverage might be welfare improving because of pecuniary externalities (Lorenzoni, 2008) • Suppose collateral constraint does not bind today (“normal times") • Households’ optimality condition for increasing debt u ✵ ✭ C t ✮ ❂ ☞ R t E t ❬ U ✵ ✭ C t ✰ 1 ✮❪ • Planner’s optimality condition for increasing debt ✷ ✸ ✹ U ✵ ✭ C t ✰ 1 ✮ � ✔ t ✖ t ✰ 1 ❅ q t ✰ 1 ❅ C t ✰ 1 ✻ ✼ u ✵ ✭ C t ✮ ❂ ☞ R t E t ✺ ✿ ✻ ✼ ❅ C t ✰ 1 ❅ � b t ✰ 1 ⑤ ④③ ⑥ ✕ 0 Planner internalizes that higher leverage leads to more sensitive asset prices if constraint binds tomorrow. Households’ don’t.
R OLE FOR F INANCIAL P OLICIES Ex-ante interventions ✮ Imposing restrictions on leverage might be welfare improving because of pecuniary externalities (Lorenzoni, 2008) • Suppose collateral constraint does not bind today (“normal times") • Households’ optimality condition for increasing debt u ✵ ✭ C t ✮ ❂ ☞ R t E t ❬ U ✵ ✭ C t ✰ 1 ✮❪ • Planner’s optimality condition for increasing debt ✷ ✸ ✹ U ✵ ✭ C t ✰ 1 ✮ � ✔ t ✖ t ✰ 1 ❅ q t ✰ 1 ❅ C t ✰ 1 ✻ ✼ u ✵ ✭ C t ✮ ❂ ☞ R t E t ✺ ✿ ✻ ✼ ❅ C t ✰ 1 ❅ � b t ✰ 1 ⑤ ④③ ⑥ ✕ 0 Planner internalizes that higher leverage leads to more sensitive asset prices if constraint binds tomorrow. Households’ don’t.
R OLE FOR F INANCIAL P OLICIES Ex-post interventions ✮ Mitigating restrictions on leverage might be welfare improving • If constraint binds today, incentives to relax it • How? Depends on the model at hand • Transfer from one sector to another • Subsidizing debt
C RISIS D YNAMICS WITH AND WITHOUT OPTIMAL POLICY
C HALLENGES FOR POLICYMAKERS 1 Optimal policies are complex • Trade-off between taxing and subsidizing credit • Simple rules (e.g. constant capital requirement) may do more harm than not 2 Policies might not be credible (Bianchi and Mendoza, 2016) • Asset prices depend on future discounted value of dividends • In crises time, policy-makers have incentives to announce future policies that would boost asset values. Those policies might not be optimal ex-post 3 Issues of coordination between monetary and financial authority
P OINT 1: T HEORY AND M EASUREMENT • Models with occasionally binding constraints hard to analyze numerically (global methods required, curse of dimensionality) • Implication: Models often stylized, might be a constraint for measurement • Question: is there a role for a less structural approach? • In this class of models, general formulas for optimal financial taxes as known functions of Lagrange multipliers and price elasticities. Can we use them as sufficient statistics? (Chetty, 2008) • Multipliers can be computed as wedges from asset prices (Garleanu et al., 2012; Bocola, 2016) • Can we measure price elasticities? • Advantage: calculations more robust
P OINT 1: T HEORY AND M EASUREMENT • Models with occasionally binding constraints hard to analyze numerically (global methods required, curse of dimensionality) • Implication: Models often stylized, might be a constraint for measurement • Question: is there a role for a less structural approach? • In this class of models, general formulas for optimal financial taxes as known functions of Lagrange multipliers and price elasticities. Can we use them as sufficient statistics? (Chetty, 2008) • Multipliers can be computed as wedges from asset prices (Garleanu et al., 2012; Bocola, 2016) • Can we measure price elasticities? • Advantage: calculations more robust
P OINT 1: T HEORY AND M EASUREMENT • Models with occasionally binding constraints hard to analyze numerically (global methods required, curse of dimensionality) • Implication: Models often stylized, might be a constraint for measurement • Question: is there a role for a less structural approach? • In this class of models, general formulas for optimal financial taxes as known functions of Lagrange multipliers and price elasticities. Can we use them as sufficient statistics? (Chetty, 2008) • Multipliers can be computed as wedges from asset prices (Garleanu et al., 2012; Bocola, 2016) • Can we measure price elasticities? • Advantage: calculations more robust
P OINT 1: T HEORY AND M EASUREMENT • Models with occasionally binding constraints hard to analyze numerically (global methods required, curse of dimensionality) • Implication: Models often stylized, might be a constraint for measurement • Question: is there a role for a less structural approach? • In this class of models, general formulas for optimal financial taxes as known functions of Lagrange multipliers and price elasticities. Can we use them as sufficient statistics? (Chetty, 2008) • Multipliers can be computed as wedges from asset prices (Garleanu et al., 2012; Bocola, 2016) • Can we measure price elasticities? • Advantage: calculations more robust
P OINT 1: T HEORY AND M EASUREMENT • Models with occasionally binding constraints hard to analyze numerically (global methods required, curse of dimensionality) • Implication: Models often stylized, might be a constraint for measurement • Question: is there a role for a less structural approach? • In this class of models, general formulas for optimal financial taxes as known functions of Lagrange multipliers and price elasticities. Can we use them as sufficient statistics? (Chetty, 2008) • Multipliers can be computed as wedges from asset prices (Garleanu et al., 2012; Bocola, 2016) • Can we measure price elasticities? • Advantage: calculations more robust
P OINT 2: O THER P RUDENTIAL P OLICIES • Paper focuses on management of credit booms/busts • Emerging markets have historically pursued several other policies to reduce the likelihood of financial crises • Accumulation of foreign reserves (Obstfeld, Shambaugh and Taylor, 2010; Ainzemann and Lee, 2008) • Models with collateral constraints offer a rationale to these types of prudential policies too • Here is an example from Bocola and Lorenzoni (2016)
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